Court Procedure Matters

Coca-Cola is seeking a re-determination in Tax Court of certain Internal Revenue Service (IRS) transfer-pricing adjustments relating to its 2007–2009 tax years. In the case, the IRS moved for partial summary judgment seeking a ruling that a 1996 Internal Revenue Code Section 7121 “closing agreement” executed by the parties is not relevant to the case before the court.

Closing Agreement Background

Following an audit of the taxpayer’s transfer pricing of its tax years 1987–1989, the parties executed a closing agreement for Coca-Cola’s 1987–1995 tax years. In the closing agreement, the parties agreed to a transfer pricing methodology, in which the IRS agreed that it would not impose penalties on Coca-Cola for post-1995 tax years if Coca-Cola followed the methodology agreed upon. Despite following the agreed-to methodology for its post-1995 tax years, the IRS determined income tax deficiencies for Coca-Cola’s 2007–2009 tax years, arguing that pricing was not arm’s-length. Continue Reading Tax Court: Prior Closing Agreement May Have Relevance in Coca-Cola’s Transfer Pricing Case

We have previously written about QinetiQ U.S. Holdings. Inc.’s (QinetiQ) fight to apply the Administrative Procedure Act (APA) to notices of deficiency issued by the Internal Revenue Service (IRS). (See below for our recent coverage.)

In short, the Tax Court and the US Court of Appeals for the Fourth Circuit rejected QinetiQ’s argument that a one-sentence reason for a deficiency determination contained in a notice of deficiency violated the APA because it was arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Undeterred, QinetiQ filed a petition for certiorari seeking review from the Supreme Court. Alas, the saga ends for QinetiQ as the Supreme Court denied the petition this morning.

Practice Point:  Although QinetiQ was not successful in its APA arguments, other APA arguments in the tax law have gained considerable traction in recent years. We will be posting soon on the recent order out of the Western District of Texas invaliding Treas. Reg. § 1.7874-8T on the grounds that this temporary regulations was unlawfully issued without adherence to the APA’s notice-and-comment requirements. Additionally, as we previously noted, other procedural arguments exists when a notice of deficiency contains a minimal explanation, such as potentially shifting the burden of proof to the IRS.

See past coverage:

 

On September 29, 2017, Judge Mark Holmes of the United States Tax Court (Tax Court) issued an order in the estate tax valuation case brought by the Estate of Michael Jackson (the Estate). In the case, the Estate moved to strike the testimony of the Internal Revenue Service’s (IRS) valuation expert witness on the grounds that he lied. The IRS acknowledged that its expert “did not tell the truth when he testified that he did not work on or write a valuation report for the IRS Examination Division in the third-party taxpayer audit.” Apparently, the expert had worked on the valuation of Whitney Houston’s Estate on behalf of the IRS, and failed to list the engagement in his report. He also omitted one publication that he wrote and one case in which he provided expert-witness testimony at a deposition.

The question for the Court was the proper remedy for the omissions, with sanctions ranging from striking all of the expert’s testimony (and thereby depriving the IRS of the only evidence in its favor on the key issues in the case) to discounting the expert’s testimony and weight to be given to his opinions. The Court decided to take the latter route.

The Court explained that striking expert testimony pursuant to Tax Court Practice and Procedure Rule 143(g) (governing expert witness reports) occurs when a putative expert omits information from the report without good cause for the omission. In this case, the Court explained that the IRS’s expert failed to disclose his valuation work on his long list of expert-testimony engagements attached to his resume, but ruled that the omission was merely a “clerical error.” However, the expert did provide false testimony at trial when he testified he did not work on or write a valuation report in the matter involving Whitney Houston’s Estate. The Court determined that there had to be some negative consequences for the expert’s false testimony, and settled on discounting his credibility and opinions.

Practice Point: The order in Estate of Michael Jackson, as well as the Tax Court’s prior opinion in Tucker v. Commissioner, TC Memo. 2017-183, highlight a very important aspect of preparing an expert report for submission in Tax Court: it must be complete and accurate at the time of its submission. It is good practice to run a litigation database search (e.g., Lexis or Westlaw) on your expert’s testimony experience as a check on what the expert has listed in his report.

Female tax professionals gathered in McDermott Will & Emery’s New York office for an annual New York rendition of Tax in the City®: A Women’s Tax Roundtable on Thursday, September 14. Featuring a CLE/CPE presentation about Privilege and the Ethics of Social Media by Kristen Hazel and Robin Greenhouse, an update on tax reform by Sandra McGill and an overview of recent state and local tax news by Alysse McLoughlin, the event culminated in a networking reception over cocktails.

Topics covered at the event included:

  • Best practices for preserving attorney-client privilege and work product protection; strategies to prevent an inadvertent waiver.
  • Ethics of social media (think before you post).
  • Tax reform:
    • Where are we now (framework to be issued week of September 25 and legislation sometime in October, possibly after budget).
    • What could tax reform look like (e.g., reduced tax rate, one-time tax on unrepatriated foreign earnings, move to territorial tax with DRD and corresponding changes to foreign tax credit system, changes to IRS Subpart F, elimination of certain deductions and/or adjustments to the taxation of carried interests).
    • What should taxpayers be thinking about (e.g., taking steps to best position your organization to proactively react to tax reform both now and when the reform measures become effective).
  • Status of certain tax regulations identified in Notice 2017-38 per mandate of EO 13789: Treasury provided recommendations to President Trump on September 18, 2017, and its report should be published sometime this month. We discussed possible change/revocation/deferred effective dates for regulations under Sections 367, 385 and 987 and steps taxpayers are taking today to address these regulations.
  • Partnership Update:
    • New TEFRA rules are effective January 1, 2018: TEFRA partnership agreements should be reviewed; assess whether the agreement should be amended (or other agreements implemented) to address these new rules.
    • Grecian Magnesite Mining: Tax Court held that gain derived by foreign person from disposition of its interest in a partnership engaged in US trade or business was treated as the disposition of a capital asset not as the disposition of the partner’s share of the underlying partnership assets and was not subject to US federal income tax as effectively connected income. It is unclear whether this case will be appealed.
  • State tax apportionment issues: We discussed the difficulty in establishing the proper level of reserves due to both the uncertainty in applying the statutory sourcing methods and the state taxing authorities’ ability to use their discretionary authority to revise the statutory sourcing methods.

We invite all tax professionals who identify as female to join Tax in the City®’s official LinkedIn group to continue the conversation and share tax developments in between events and meetings! Click here to join.

Established in 2014 by McDermott Will & Emery LLP, Tax in the City® is a discussion and networking group for women in tax that fosters collaboration and mentorship and facilitates in-person connections and roundtable events around the country. This New York edition of Tax in the City® was the third event this year, and there are two more events in the works—an inaugural Seattle event on October 12, and then an end-of-year event in our Chicago office on December 14.

 

In Ritter v. Commissioner, TC Memo. 2017-185 (September 19, 2017), the Tax Court held that a taxpayer’s receipt of a payment from a section 468B qualified settlement fund (QSF) was includable in gross income for the 2013 taxable year. The QSF was established pursuant to a settlement agreement between a federal banking regulator and the taxpayer’s former mortgage servicer (Bank) in which the Bank agreed to take certain actions to remedy deficiencies and unsafe or unsound practices in (i) the Bank’s residential mortgage servicing and (ii) the Bank’s initiation and handling of foreclosure proceedings. The Bank foreclosed on the taxpayer’s principal residence in 2010 while the taxpayer was in bankruptcy proceedings and protected by federal bankruptcy law. Continue Reading Tax Court Holds Payment from Qualified Settlement Fund is Includable in Taxpayer’s Gross Income

The issue of whether a valid tax return has been filed usually comes up in the context of individuals. One common situation involves taxpayers who file so-called zero returns or returns with an altered jurat and protest paying any taxes. Another common situation, which has received substantial attention lately, involves whether a tax return filed after an assessment by the Internal Revenue Service (IRS) is a “return” for purposes of the Bankruptcy Code. We previously posted on the latter.

This post focuses on the uncommon situation where the IRS disputes whether a corporate taxpayer filed a valid return. As we have previously discussed, in the widely cited Beard v. Commissioner, 82 TC 766 (1984), the Tax Court defined a four-part test (the Beard Test) for determining whether a document constitutes a “return.” To be a return, a document must: (1) provide sufficient data to calculate tax liability; (2) purport to be a return; (3) be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) be executed by the taxpayer under penalties of perjury. This test applies to all types of taxpayers, and its application to corporate taxpayers was recently highlighted in New Capital Fire, Inc. v. Commissioner, TC Memo. 2017-177.

In New Capital Fire, Capital Fire Insurance Co. (Old Capital) merged into New Capital Fire, Inc. (New Capital), with New Capital surviving, on December 4, 2002. The merger was designed to be a tax-free reorganization under Internal Revenue Code (Code) Section 368(a)(1)(F). Old Capital did not file a tax return for any part of 2002 and New Capital filed a tax return for 2002 which included a pro forma Form 1120-PC, US Property and Casualty Insurance Company Income Tax Return, for Old Capital’s 2002 tax year. The IRS issued Old Capital a notice of deficiency in 2012 determining that Old Capital was required to file a return for the short tax year ending December 4, 2002, because the merger failed to meet to reorganization rules. Continue Reading Tax Court Rejects IRS Argument that Corporate Taxpayer Failed to File Valid Return

Summary judgment is a common practice in all courts, including courts hearing tax disputes. Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Full or partial summary judgment is appropriate where there is no genuine issue of material fact and a decision may be rendered as a matter of law on the issue presented. Summary judgment can be obtained by a party upon the filing of a motion if the pleadings and other evidence in the record, including any affidavits or declarations in support of or against the motion, demonstrate that no factual dispute exists. Each court has its own particular rules on motions for summary judgment, but all are grounded on the essential requirement that the pertinent facts not be in dispute. The party moving for summary judgment bears the burden of showing that no genuine issues exists as to any material fact and that it is entitled to judgment as a matter of law, with all factual materials and inferences drawn from them considered in the light most favorable to the nonmoving party. To defeat a motion for summary judgment, the nonmoving party must do more than merely allege or deny facts; it must set forth specific facts showing a genuine dispute for trial. Thus, facts that are not properly supported or that are irrelevant or unnecessary will not be counted.

The decision of whether to file a motion for summary judgment must be carefully made. In some cases the decision may be fairly straightforward because both sides agree on the pertinent facts and the issue is purely legal. However, in other cases, the factual record may not be as clear and the parties may differ on which facts are material and which properly remain in dispute. Further, a motion for summary judgment by one party may result in a cross-motion for summary judgment by the other party. Thus, the party initially moving for summary judgment needs to be confident that it will not need additional facts or supporting information from witnesses before seeking summary adjudication. Continue Reading Motion Practice – Moving for Summary Adjudication

In a long-awaited decision, the US Tax Court recently held that gain realized by a foreign taxpayer on the sale of a partnership engaged in a US trade or business was a sale of a capital asset not subject to US tax, declining to follow Revenue Ruling 91-32. The government has yet to comment regarding its intentions to appeal.

Continue Reading

Courts continue to strike down the Internal Revenue Service (IRS) as it continues to test the bounds of the attorney-client privilege and work product doctrine through the issuance of improper summonses. In the last several years, the IRS has filed numerous summons enforcement proceedings related to the production of documents generally protected by the attorney-client privilege, tax-practitioner privilege, and/or work product doctrine. These summonses include overt requests for “tax advice” and “tax analysis,” which several courts have refused to enforce. For example, see Schaeffler v. United States, 806 F.3d 34 (2d Cir. 2015).

Once again, in United States v. Micro Cap KY Insurance Co., Inc. (Eastern District of Kentucky), a federal district court rejected the IRS’s arguments and refused to enforce an inappropriate summons. The opinion is available here. The IRS filed this enforcement proceeding seeking to compel the production of confidential communications between taxpayers and the lawyers that assisted them in forming a captive insurance company. After conducting an in camera review (where the judge privately reviewed the documents without admitting them in the record), the judge found the taxpayers had properly invoked privilege since each document “predominately involve[d] legal advice within the retention of [] counsel.”

The court also rejected the government’s argument that the attorney-client privilege was waived by raising a reasonable cause and reliance on counsel defense to penalties in the taxpayers’ case filed in Tax Court. Because the government’s argument was untimely, it was waived and rejected outright. The court, however, proceeded to explain how the argument also failed on its merits. Continue Reading The IRS Is Struck Down Again in Privilege Dispute